Wednesday, April 18, 2012

Spend Less Than You Earn

The fundamental principle of financial security can be said quite simply, "Spend Less Than You Earn". Or as Saturday Night Live put it many years ago, "Don't Buy Stuff You Cannot Afford". says, Becoming Wealthy May Be Simple, But It’s Not Easy

While simple in theory, there's a few gotchas to keep in mind.
  1. You must spend less than your take-home pay which will be much less than your salary. Taxes and Social Security take a big bite out of the pay check.
  2. You need to factor in emergencies. It's not enough to say I keep my expenses within budget but this month I had to visit the vet, the doctor, the mechanic, etc and that put me over budget. Emergencies are part of life and need to be part of the budget too.
  3. You need to prepare for retirement. If you spend every penny you earn today, what will you live on when you stop working?
One way to address the issues above is the 50/30/20 budget described by Liz Weston at MSN Money.
  1. Start with your after tax income.  "If your employer deducts other expenses from your paycheck, such as 401k contributions, health insurance premiums and union dues, add those back into your net pay to get your after-tax income."
  2. Work hard to limit your "must-have" expenses to 50% of what you earn after taxes. The "must-haves" included insurance, rent/mortgage, utilities, essential food, and minimum loan payments. If you choose not to buy something (like clothing) then it is not a "must-have".
  3. Limit your "wants" to 30% of after-tax pay. This includes gifts, clothes, dining out, extra features for your TV or phone, etc. Is the Internet a want or a must-have? Think about it.
  4. Save 20% of your after-tax income for savings or early debt repayment. "Any loan payments you make above the minimum belong in this category, as do contributions to your retirement and emergency funds."
For many families this may sound impossible. But when you exceed the limits above you put yourself into an impossible situation of a debt that you cannot pay back.
 “Interest never sleeps nor sickens nor dies; it never goes to the hospital; it works on Sundays and holidays; it never takes a vacation. … Once in debt, interest is your companion every minute of the day and night; you cannot shun it or slip away from it; you cannot dismiss it; it yields neither to entreaties, demands, or orders; and whenever you get in its way or cross its course or fail to meet its demands, it crushes you.” - J. Reuben Clark Jr., 1938

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